Update on economic and monetary developments

Summary

The information that has become available since the Governing Council’s monetary policy meeting in March confirms slower growth momentum extending into the current year. While there are signs that some of the idiosyncratic domestic factors dampening growth are fading, global headwinds continue to weigh on euro area growth developments. The risks surrounding the euro area growth outlook remain tilted to the downside, on account of the persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets. At the same time, further employment gains and rising wages continue to underpin the resilience of the domestic economy and gradually rising inflation pressures. However, an ample degree of monetary accommodation remains necessary to safeguard favourable financing conditions and support the economic expansion, and thus to ensure that inflation remains on a sustained path towards levels that are below, but close to, 2% over the medium term. Significant monetary policy stimulus is being provided by the Governing Council’s forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets and the new series of targeted longer-term refinancing operations (TLTROs).

Survey indicators of global economic activity have weakened in the first quarter of 2019. In particular, global trade has continued to slow down amid the turning of the global industrial cycle and heightened trade tensions. Global inflation has subsided in the first months of this year, largely on account of a lower contribution from the energy component.

Euro area government bond yields overall declined somewhat as global risk-free rates decreased and the EONIA forward curve shifted downwards. Developments in sovereign bond spreads exhibited some heterogeneity across the euro area. Equity prices rose amid lower risk-free rates and stable and low volatility. Accordingly, yield spreads on corporate bonds narrowed. In foreign exchange markets, the euro remained broadly unchanged in trade-weighted terms.

Euro area real GDP rose by 0.2%, quarter on quarter, in the fourth quarter of 2018, following an increase of 0.1% in the third quarter. Incoming data continued to be weak, mainly on account of the slowdown in external demand, compounded by country and sector-specific factors. As the impact of these factors is turning out to be somewhat longer-lasting, the slower growth momentum is expected to extend into the current year. Looking ahead, the effect of these adverse factors is expected to unwind. The euro area expansion will continue to be supported by favourable financing conditions, further employment gains and rising wages, and the ongoing – albeit somewhat slower – expansion in global activity.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February 2019, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months. Measures of underlying inflation have remained generally muted, but labour cost pressures have strengthened and broadened amid high levels of capacity utilisation and tightening labour markets. Looking ahead, underlying inflation is expected to increase gradually over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and rising wage growth.

Regarding monetary developments, broad money (M3) growth increased to 4.3% in February 2019, from 3.8% in January. M3 growth continues to be backed by bank credit creation and the narrow monetary aggregate M1 remained the main contributor to broad money growth. The annual growth rate of loans to non-financial corporations rebounded to 3.7% in February 2019 and has moderated in recent months, reflecting the typical lagged reaction to the slowdown in economic growth. The annual growth rate of loans to households remained broadly unchanged at 3.3% in February. The euro area bank lending survey for the first quarter of 2019 suggests that overall bank lending conditions remained favourable.

Combining the outcome of the economic analysis with the signals coming from the monetary analysis, the Governing Council concluded that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

On the basis of this assessment, the Governing Council decided to keep the key ECB interest rates unchanged and continues to expect them to remain at their present levels at least through the end of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

The Governing Council confirmed that the Eurosystem will continue to reinvest, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

The precise terms of the new TLTRO series will be communicated at one of the Governing Council’s forthcoming meetings. In particular, the pricing of the new TLTRO-III operations will take into account a thorough assessment of the bank-based transmission channel of monetary policy, as well as further developments in the economic outlook. In the context of the ECB’s regular assessment, the Governing Council will also consider whether the preservation of the favourable implications of negative interest rates for the economy requires the mitigation of their possible side effects, if any, on bank intermediation.

The Governing Council reiterated its readiness to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s inflation aim in a sustained manner.


External environment

Global survey indicators point to some deceleration in global activity in the first quarter of 2019. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area rose in March (see Chart 1), as an increase in the services sector more than offset a marginal decline in manufacturing. In quarterly terms, however, the PMI in the first quarter of 2019 is below the level recorded in 2017 and the first half of 2018, consistent with some deceleration in the global growth momentum. Across advanced economies, the US Markit PMI was broadly unchanged while the all-industry survey indicator published by the Institute for Supply Management (ISM) declined from rather high levels during the first quarter. PMIs also decreased in the United Kingdom and Japan, on the back of weaker readings in March. In emerging market economies, the quarterly PMI picked up strongly in Brazil, while decreasing in India and Russia. The PMI remained unchanged in China in the first quarter, although it recorded a strong increase in March.

 

Chart 1

Global composite output PMI

(diffusion index)

48 50 52 54 56 58 2012 2013 2014 2015 2016 2017 2018 2019 Global composite output excluding the euro area Global composite output excluding the euro area – long-term average Advanced economies excluding the euro area Emerging market economies

Sources: Haver Analytics, Markit and ECB staff calculations.
Notes: The latest observations are for March 2019. “Long-term average” refers to the period from January 1999 to March 2019.

Global trade indicators signal a continued weakness at the start of the year. The volume of merchandise imports decreased by 1.9% in January 2019, in three-month-on-three-month terms, particularly on account of sharp declines in Asian countries. This decrease is partly related to the significant volatility of Chinese trade data around the Lunar New Year, which makes it difficult to interpret the January data. At the same time, the PMI new export orders remained below the expansionary threshold in March (see Chart 2). A broader measure, based on a principal component of leading indicators of global trade, qualifies this picture and points to a marginal increase in world trade in the first quarter of 2019, following subdued developments in the second half of last year.

The ongoing slowdown in world trade is partly driven by the turning of the global industrial cycle. A maturing global business cycle typically leads, via lower investment activity, to a moderation in global trade. This pattern has been amplified at the current juncture by the fact that much of the weakness in the global economy has been concentrated in industrial activity. In fact, the industrial and trade cycles tend to be highly correlated.

 

Chart 2

Global trade and surveys

(left-hand scale: three-month-on-three-month percentage changes; right-hand scale: diffusion index)

46 47 48 49 50 51 52 53 54 55 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 2012 2013 2014 2015 2016 2017 2018 2019 Global merchandise imports (left-hand scale) Global PMI, manufacturing output, excluding the euro area (right-hand scale) Global PMI, manufacturing new export orders, excluding the euro area (right-hand scale)

Sources: Markit, CPB Netherlands Bureau for Economic Policy Analysis and ECB staff calculations.
Note: The latest observations are for January 2019 for global merchandise imports and March 2019 for the PMIs.

World trade has also been affected by other factors, including heightened trade tensions. US imports from China have fallen particularly sharply in the industries affected by the tariffs, but a sharp moderation has also occurred across other Asian economies. While this could be a sign of weaker domestic demand in China, it could also be the result of industry-specific developments, particularly in electronic products and cars. Both sectors are highly trade-intensive and have a high share in Asian trade. Box 1 discusses the role that a maturing tech cycle may have played in the trade slowdown observed in China and other key Asian economies.

Global inflation remained stable in February. Annual consumer price inflation in the Organisation for Economic Co-operation and Development (OECD) countries remained unchanged in February at 2.1%, following a sequence of declines since the peak registered in October last year. Excluding food and energy prices, OECD annual inflation slowed marginally to 2.1%. Tight labour market conditions across major advanced economies have so far translated into only moderate wage increases, suggesting that the underlying inflation pressures remain subdued. Looking ahead, inflation is expected to remain subdued in the short term, while diminishing spare capacity at the global level is expected to support underlying inflation in the medium term.

Oil prices have continued to increase since mid-March. After the surge in mid-February, which followed the release of data showing an improvement in OPEC+ compliance with its supply-cut agreements, oil prices have risen further since early March to a level of around 70 USD/barrel. After OPEC+ reset its two-year-old agreement at the end of last year in an effort to reduce oil supply, overall production by the cartel has decreased since January 2019. Moreover, US sanctions against Iran and Venezuela continued to affect supply, exacerbated further by power outages in Venezuela, which weighed on output. Among non-oil commodities, metal prices and food prices have remained broadly unchanged since early March.

The expansion in the US remains sustained, but shows signs of maturing. US real GDP expanded at an annual rate of 2.2% in the fourth quarter of 2018. The increase in real GDP in the fourth quarter mainly reflected positive contributions from private consumption and non-residential fixed investment, while the contributions from net exports and government spending were negative. While overall GDP growth remains supported by strong fundamentals, economic activity is expected to decelerate in the first quarter of this year, amid one-off adverse factors – such as the partial government shutdown – and mixed incoming data. At the same time, inflationary pressures remain contained, in spite of rising wages. Annual headline CPI inflation slowed down slightly to 1.5% in February. The decline in inflation was mainly driven by a sharp drop in energy prices. CPI inflation excluding food and energy prices dropped marginally to 2.1% in February. By contrast, in line with a tight labour market, average hourly earnings rose by 3.4% year-on-year, continuing an upward trend that started in 2015.

Economic activity slowed in Japan in early 2019, following a rebound towards the end of last year. Real GDP increased by 0.5%, quarter on quarter, in the fourth quarter of 2018, mainly supported by domestic demand, particularly non-residential investment. However, high frequency indicators point to a slowdown in underlying momentum at the start of the year. Industrial production was very weak, currently standing below the Q4 2018 levels. January-February average real goods exports are lower than last year, suggesting ongoing weakness in external demand. Consumer price inflation continued to slow at the start of 2019, largely reflecting developments in food and energy prices. Annual headline inflation declined to 0.2% in both January and February, reflecting mostly a decline in the energy price contribution and strong declines in fresh food prices. Core inflation (i.e. excluding food and energy) has picked up slightly to 0.3%.

In the United Kingdom, GDP growth slowed markedly in the final quarter of 2018 in an environment of high uncertainty related to Brexit. Quarterly real GDP growth slowed to 0.2% in the fourth quarter of last year, following robust growth in the previous quarter. Short-term indicators suggest continued subdued GDP growth in the first quarter of 2019, as elevated Brexit-related uncertainty dampens consumption and investment. Despite slowing global growth momentum, UK exports rebounded strongly in the second half of the year, aided by a slight depreciation of the pound sterling. However, net trade continues to contribute negatively to growth, as imports rebounded even more strongly – in large part as a result of stockpiling by firms and consumers in anticipation of Brexit. After a slight up-tick in the middle of 2018, annual CPI inflation has continued to decline, falling to 1.8% in the first two months of 2019. This is well below the depreciation-induced peak at 3.0% seen one year earlier and reflects both the waning impact of earlier strong rises in import prices and rapid declines in energy prices from the autumn of 2018.

Economic growth is stabilising in China. Weaker activity in the manufacturing sector is partly offset by resilience in services. In the first two months of the year, industrial production softened further and fixed-asset investment growth recovered slightly, while growth in nominal retail sales remained robust. This mixed picture was confirmed by the manufacturing and services PMIs in the first quarter, with services holding up better. At the same time, trade activity has been very volatile in recent months, partly reflecting distortions related to the Lunar New Year. Following weak data for February, the authorities expect some rebound in March. Annual headline CPI inflation eased to 1.5% in February due to the sharp decline in food price contribution. Inflation excluding food and energy also slowed to 1.8%. At the same time, annual producer price inflation remained steady at 0.1% in February, as lower oil prices were offset by a price increase in the mining and quarrying sector.


Financial developments

Long-term yields have declined in the euro area and in the United States. During the period under review (from 7 March to 9 April 2019) the GDP-weighted euro area ten-year sovereign bond yield declined marginally to 0.72% (by around 5 basis points) in a context of decreasing global risk-free rates and stable or declining financial market volatility (see Chart 3). Ten-year sovereign bond yields fell by around 15 basis points in the United States and by slightly less than 10 basis points in the United Kingdom, to 2.50% and 1.10% respectively.

 

Chart 3

Ten-year sovereign bond yields

(percentages per annum)